Escalation Clause: Everything You Need to Know
An escalation clause is used in buyers' offers for real estate to improve the buyer's chances of succeeding against competitors' offers.3 min read
An escalation clause is used in buyers' offers for real estate to improve the buyer's chances of succeeding against competitors' offers. The clause automatically increases the purchase price the buyer is offering in order to beat competing offers without overpaying for the property. Escalation clauses typically have an upper limit on the amount the purchase price is allowed to increase.
Escalation clauses are not always appropriate or acceptable. Though buyers may often worry that another buyer will beat them to the purchase with a better offer, most of the time it isn't much of a concern. Therefore, unless you know that you will be competing with other offers, you should avoid using this clause in your offer.
Components of an Escalation Clause
The typical escalation clause has the following basic components:
- The original offer for the purchase of the property.
- The amount you are willing to raise the offer to compete with other bids.
- The maximum amount you are willing to pay.
Ethics of the Escalation Clause
Real estate agents must follow a certain code of ethics along with other regulations when escalation clauses are used by their clients. For one thing, the agent must promote their client's best interests. They must also find out all possible information and disclose it to the client, and act in a fair and honest manner toward everyone who is involved. Of course, the buyer's and seller's interests are opposed to one another, so their representatives are responsible for protecting their own clients' interests as long as their actions are fair to the other.
There has been concern that escalation clauses may be unethical or cause other complications. Reasons include the following:
- Agents for sellers should disclose the number of competing offers to other bidders but not the amount of each offer.
- Although buyers can use the escalation clause to gain the advantage over other bidders, they need to understand that their offer may not be revoked, and escalation clauses can result in a bidding war.
- Buyers will not be able to see other offers to confirm the amount of the offers they are competing with; they must trust the other agent.
- When a buyer submits an offer that includes an escalation clause, their agent must make sure that the seller's agent knows that the clause is present. Otherwise, it may be overlooked.
- There is no requirement to confirm the second best offer to the buyer.
Sellers can take certain steps to protect their interest when an offer with an escalation clause is received:
- First, know that offers with escalation clauses are a possibility and it's up to the seller whether or not to accept an offer that includes one.
- Be aware of the offer price, including the highest amount it will reach.
- Decide how to proceed when there are multiple offers; sellers can choose to accept an offer, reject all offers, or make a counteroffer. Sellers can also choose to set a specific price for the property and dismiss the escalation clause.
- Be aware that accepting an offer with an escalation clause creates an agreement of purchase and sale, and make sure the correct price is documented on the agreement before it is signed.
Benefits and Drawbacks of Escalation Clauses
One of the pros of including an escalation clause is that it provides peace of mind to the buyer. Making offers on real estate can be stressful, and if it's a property you really love, you may worry that you will lose it to a higher offer. An escalation clause gives you a better chance of success, while at the same time helping you to avoid paying more for the property than you need to.
On the other hand, there are drawbacks. For one thing, the agent representing the seller may not understand how escalation clauses work. If that happens, the seller will not be aware that you are willing to increase your offer and may choose a competing offer regardless.
For the buyer, the main drawback is that the seller will be aware of your position, knowing that you will increase your offer if outbid. Therefore, even if there are no competing offers, the seller knows that if they counteroffer, there is a higher likelihood that you will bargain.
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